Hospitals make money through a complex mix of patient care payments, government subsidies, drug pricing programs, facility fees, and investment income. But the margins are razor-thin. The median operating margin for nonprofit hospitals in 2024 was just 1.2%, up from negative 0.5% the year before. That means for every $100 a hospital brings in, it keeps about $1.20 after expenses. Understanding where that revenue comes from, and why some hospitals thrive while others barely break even, starts with who’s actually paying the bills.
The Payer Mix: Where the Real Money Comes From
Not all patients are worth the same amount to a hospital’s bottom line, and the single biggest factor in a hospital’s financial health is its “payer mix,” the proportion of patients covered by private insurance versus government programs. Commercially insured patients represent more than 40% of a typical hospital’s patient revenue but generate almost all of its operating profit. Private insurers paid hospitals about 145% of the actual cost of care in 2018, meaning hospitals earned roughly 45 cents of profit on every dollar of cost for privately insured patients.
Medicare, which covers about one-third of all hospital revenue, is a different story. Medicare paid just 87% of hospitals’ costs in 2018, down from 99% in 2000. That gap has widened steadily for nearly two decades. Medicaid reimbursement rates are even lower. So a hospital located in an area with a large elderly or low-income population, and relatively few commercially insured patients, faces a structural financial disadvantage that no amount of efficiency can fully solve.
This is why hospitals aggressively court relationships with large employers and commercial insurers, and why mergers and acquisitions often target facilities with favorable payer mixes.
Inpatient vs. Outpatient Revenue
Hospital revenue splits into two broad buckets: inpatient care (overnight stays, surgeries, ICU treatment) and outpatient services (same-day procedures, imaging, lab work, emergency visits that don’t result in admission). Looking at Medicare alone, inpatient admissions accounted for $119 billion across about 10 million stays in 2017, while outpatient services brought in $66 billion across roughly 200 million visits.
The trend across the industry has been a steady shift toward outpatient care. Procedures that once required a hospital stay, from joint injections to certain heart procedures, now happen in outpatient departments or ambulatory surgery centers. Hospitals have adapted by expanding outpatient facilities, which typically cost less to operate and can generate high volume. This shift also connects to one of the more controversial revenue strategies hospitals use: facility fees.
Facility Fees: The Charge You Might Not Expect
When you visit a doctor’s office that’s owned by a hospital system, you may receive two separate bills: one for the doctor’s professional services and one called a “facility fee” charged by the hospital. The professional fee is roughly the same whether your doctor works independently or for a hospital (about $70 on average for common visit types in Colorado’s data). The facility fee is the extra charge layered on top, simply because the visit took place at a hospital-owned location.
These fees vary wildly. In Washington state, one hospital system reported a maximum outpatient facility fee exceeding $6,900 for a single visit, while others charged less than $200. Commercial insurers pay the most for these fees, reimbursing 2.5 to 3.5 times more per visit at hospital outpatient departments than any other payer, including Medicare and Medicaid.
This revenue stream has been growing fast. In Connecticut, total facility fee revenue from off-campus hospital outpatient departments rose 42% between 2019 and 2023, climbing from $430 million to $611 million. Patient visits with facility fees grew 12.8% over the same period, meaning the revenue increase was driven partly by higher fees per visit, not just more patients walking through the door. Colorado saw outpatient facility fee reimbursement increase by an average of 6.5% per year between 2017 and 2022.
This is a key reason hospitals have been acquiring independent physician practices and converting them into hospital outpatient departments. Once a freestanding clinic becomes hospital-affiliated, it can bill facility fees that weren’t previously charged, boosting revenue without changing the care delivered.
The 340B Drug Pricing Program
One of the less visible but increasingly significant revenue sources for hospitals is a federal program called 340B. Designed to help hospitals that serve vulnerable populations, the program lets qualifying hospitals buy outpatient drugs from manufacturers at steep discounts. The hospital then dispenses those drugs to patients and gets reimbursed by insurers at the regular, much higher rate. The hospital keeps the difference.
The program doesn’t dictate how much insurers pay for drugs distributed by participating facilities. So a hospital might purchase a medication at the discounted 340B price, administer it to a commercially insured patient, and collect the full insurance reimbursement. The spread between purchase price and reimbursement can be substantial, particularly for expensive specialty drugs.
Hospitals have expanded their 340B revenue by acquiring off-site clinics. When an independent practice gets consolidated with a 340B-eligible hospital, that clinic becomes eligible to purchase drugs at 340B prices, increasing the volume of discounted purchases. A 2010 rule change also allowed 340B facilities to contract with an unlimited number of pharmacies, further expanding the reach of the program. These financial incentives have drawn scrutiny: the Congressional Budget Office has noted that 340B facilities have an incentive to prescribe more drugs and to shift prescriptions toward drugs where the gap between the insurance rate and the discounted purchase price is largest.
Government Subsidies and Uncompensated Care
Hospitals don’t collect payment for every patient they treat. Uncompensated care, the combination of bad debt and charity care, cost community hospitals $42.7 billion in 2020 according to the American Hospital Association. That figure doesn’t even include the shortfalls from Medicare and Medicaid paying below cost.
To partially offset these losses, the federal government provides Disproportionate Share Hospital (DSH) payments to facilities that treat a large share of Medicaid and uninsured patients. Federal law requires state Medicaid programs to make these payments to qualifying hospitals. The payments are capped at each hospital’s actual uncompensated care costs, so they function as a partial reimbursement for money already lost rather than a profit center. Medicare also contributed about $6 billion in 2017 specifically for uncompensated care provided to non-Medicare patients.
These subsidies are essential for safety-net hospitals in low-income areas. Without them, many would close.
Nonprofit vs. For-Profit: A Smaller Gap Than You’d Think
About 56% of US community hospitals are nonprofit, meaning they’re exempt from federal, state, and local taxes. In exchange, the IRS requires them to meet a “community benefit standard,” demonstrating that they promote health for a broad enough class of people to benefit the community. Factors the IRS weighs include operating an emergency room open to everyone regardless of ability to pay, maintaining an open medical staff policy, accepting Medicare and Medicaid patients, and providing financial assistance to people who can’t afford care.
Nonprofit hospitals are allowed to generate surplus revenue. They just can’t distribute profits to shareholders. Surplus funds are expected to go toward improving facilities, advancing medical training and education, or expanding patient care. In practice, large nonprofit hospital systems can accumulate billions in reserves and investment portfolios.
For-profit hospitals, which make up roughly 25% of community hospitals, operate much the same way on the clinical side. The key differences are that they pay taxes, can issue stock and distribute dividends, and face direct pressure from investors to grow earnings. They tend to be more aggressive about cost-cutting and revenue optimization, though nonprofit systems have increasingly adopted similar strategies.
Investment Income and Non-Operating Revenue
Patient care isn’t the only thing keeping hospitals financially afloat. Non-operating revenue, which includes investment income, rental revenue from medical office space, government grants, and philanthropic donations, plays a critical role for many hospitals. Some hospitals use non-operating revenue to offset operating losses entirely, maintaining positive total margins even when they lose money on patient care.
Large hospital systems and academic medical centers often hold substantial endowments and investment portfolios. In years when markets perform well, investment returns can represent a meaningful share of total income. When markets drop, hospitals that depend on investment income can see their financial position deteriorate quickly, even if patient volumes remain steady. This dynamic means that a hospital’s financial health can be tied as much to Wall Street as to the patients in its beds.
Why Margins Stay So Thin
With all these revenue streams, it might seem like hospitals should be comfortably profitable. Most aren’t. Labor is the single largest expense, typically consuming more than half of a hospital’s budget. Staffing shortages, particularly in nursing, have driven wages sharply higher in recent years. Supply costs, technology investments, regulatory compliance, and the cost of maintaining aging buildings eat up much of the rest.
The fundamental tension is that hospitals’ largest payers, Medicare and Medicaid, reimburse below cost, while the commercially insured population that subsidizes those losses is shrinking in some markets. Hospitals respond by pursuing the strategies described above: acquiring physician practices to capture facility fees, expanding 340B drug programs, negotiating higher rates with commercial insurers, and diversifying into outpatient services. Each of these strategies works at the margins, but the overall business of running a hospital remains one of the tightest financial balancing acts in any industry.